Research
Bond Supply and Excess Bond Returns
May 2008. Comments on Robin Greenwood and Dimitri Vayanos’ paper for the IGM “Beyond Liquidity ” conference at the GSB Gleacher center, May 9-10 2008. The paper from Dimitri’s website . I learned two important lessons in reading and thinking about this paper. 1) When arbitrageurs are limited by risk-bearing capacity, “downward-sloping” demands depend on correlations. The paper and my comments have a lovely example in which arbitrageurs are asked to hold more long-term bonds and less short-term bonds. The result is that all yields go up! Why don’t long yields go up and short yields go down? Because risks are described by a one-factor model, so all that matters is how much overall duration risk arbitrageurs have to hold. 2) We’re probably doing a bad job of correcting for serial correlation in all predictive regressions. Typically, we think expected returns move slowly over time. The right hand variable also moves slowly over time, but doesn’t capture all of the expected return variation. This situation means that residuals have a slow-moving AR(1) plus an unforecastable component, which is the same thing as an ARMA(1,1). This structure will be very poorly captured by standard “nonparametric” procedures such as Newey-West, since you’re unlikely to put in enough lags to capture the long-run component, and also poorly captured by parametric procedures like fitting an AR(1). “Short” samples make the problem worse. More in the comments.
May 2008. Comments on Robin Greenwood and Dimitri Vayanos’ paper for the IGM “Beyond Liquidity ” conference at the GSB Gleacher center, May 9-10 2008. The paper from Dimitri’s website . I learned two important lessons in reading and thinking about this paper. 1) When arbitrageurs are limited by risk-bearing capacity, “downward-sloping” demands depend on correlations. The paper and my comments have a lovely example in which arbitrageurs are asked to hold more long-term bonds and less short-term bonds. The result is that all yields go up! Why don’t long yields go up and short yields go down? Because risks are described by a one-factor model, so all that matters is how much overall duration risk arbitrageurs have to hold. 2) We’re probably doing a bad job of correcting for serial correlation in all predictive regressions. Typically, we think expected returns move slowly over time. The right hand variable also moves slowly over time, but doesn’t capture all of the expected return variation. This situation means that residuals have a slow-moving AR(1) plus an unforecastable component, which is the same thing as an ARMA(1,1). This structure will be very poorly captured by standard “nonparametric” procedures such as Newey-West, since you’re unlikely to put in enough lags to capture the long-run component, and also poorly captured by parametric procedures like fitting an AR(1). “Short” samples make the problem worse. More in the comments.
Risks and Regimes in the Bond Market
April 2008. Comments on Atkeson and Kehoe’s paper for the 2008 Macroeconomics Annual. Risk premia are important for understanding interest rates, and monetary policy. I see no evidence for “anchored expectations” in interest rate data. Once you take account of risk premiums, expected long run interest rates are still very volatile. The yield curve has not become more downward sloping on average, as it should if inflation risks have decreased. If anything, risk premia in long-term bonds are increasing. Atkeson and Kehoe advocate a fascinating view that risk premia cause monetary policy, not vice versa.
April 2008. Comments on Atkeson and Kehoe’s paper for the 2008 Macroeconomics Annual. Risk premia are important for understanding interest rates, and monetary policy. I see no evidence for “anchored expectations” in interest rate data. Once you take account of risk premiums, expected long run interest rates are still very volatile. The yield curve has not become more downward sloping on average, as it should if inflation risks have decreased. If anything, risk premia in long-term bonds are increasing. Atkeson and Kehoe advocate a fascinating view that risk premia cause monetary policy, not vice versa.
Decomposing the Yield Curve
Manuscript, first big revision, March 14 2008. With Monika Piazzesi. We work out an affine term structure model that incorporates our bond risk premia from “Bond Risk Premia” in the AER. There are lots of interesting dynamics – level, slope and curvature forecast future bond risk premia, and we discover that market prices of risk are really simple. We use the model to decompose the yield curve – given a yield (forward) curve today, how much is expected future interest rates, and how much is risk premium? How does the yield or forward rate premium correspond to the term structure of expected return premia? Was the conundrum a conundrum? Slides from 2010 AFA meetings Data and Programs.
Manuscript, first big revision, March 14 2008. With Monika Piazzesi. We work out an affine term structure model that incorporates our bond risk premia from “Bond Risk Premia” in the AER. There are lots of interesting dynamics – level, slope and curvature forecast future bond risk premia, and we discover that market prices of risk are really simple. We use the model to decompose the yield curve – given a yield (forward) curve today, how much is expected future interest rates, and how much is risk premium? How does the yield or forward rate premium correspond to the term structure of expected return premia? Was the conundrum a conundrum? Slides from 2010 AFA meetings Data and Programs.
Financial markets and the Real Economy
In Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, 237-325. Everything you wanted to know, but didn’t have time to read, about equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk.
In Rajnish Mehra, Ed. Handbook of the Equity Premium Elsevier 2007, 237-325. Everything you wanted to know, but didn’t have time to read, about equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk.
This article appeared four times, getting better each time. (Why waste a good article by only publishing it once?) The link above is the last and the best. The previous versions were NBER Working paper 11193, Financial Markets and the Real Economy Volume 18 of the International Library of Critical Writings in Financial Economics, John H. Cochrane Ed., London: Edward Elgar. March 2006, and in Foundations and Trends in Finance 1, 1-101, 2005.
What ends recessions?
By David and Christina Romer, 1994 NBER Macroeconomics Annual 58-74. JSTOR What are monetary policy shocks? The fed never says “and another 50 bp for the heck of it.” This led to “What do the VARs mean?”
By David and Christina Romer, 1994 NBER Macroeconomics Annual 58-74. JSTOR What are monetary policy shocks? The fed never says “and another 50 bp for the heck of it.” This led to “What do the VARs mean?”
Daily Monetary Policy Shocks and the Delayed Response of New Home Sales
By James D. Hamilton. April 2007 Comments given at NBER Monetary Economics program meeting, NY. Includes some new thoughts on what a monetary policy shock is.
By James D. Hamilton. April 2007 Comments given at NBER Monetary Economics program meeting, NY. Includes some new thoughts on what a monetary policy shock is.
Portfolio theory
Feb. 20 2007 This is a draft of a portfolio theory chapter for the next revision of Asset Pricing. I (of course) take a p = E(mx) approach to portfolio theory before covering the classic Merton-style direct approach. I emphasize the importance of outside income.
Feb. 20 2007 This is a draft of a portfolio theory chapter for the next revision of Asset Pricing. I (of course) take a p = E(mx) approach to portfolio theory before covering the classic Merton-style direct approach. I emphasize the importance of outside income.
“The Returns to Currency Speculation”
by Craig Burnside, Martin Eichenbaum, Isaac Kleshchelski and Sergio Rebelo. Comments given at Jan 2007 AEA/AFA meetings. (Slides only)
by Craig Burnside, Martin Eichenbaum, Isaac Kleshchelski and Sergio Rebelo. Comments given at Jan 2007 AEA/AFA meetings. (Slides only)
‘Macroeconomic Implications of Changes in the Term Premium’
By Glenn Rudebusch, Brian Sack and Eric Swanson. Comments given at the conference “Frontiers in Monetary Policy Research” at the St. Louis Federal Reserve, October 19 2006. Of course, I can’t stick to the topic and offer a survey instead. In particular, lots of salty comments on the “conundrum” in long bond prices (silly, in my view). The paper from the St. Louis Fed website.
By Glenn Rudebusch, Brian Sack and Eric Swanson. Comments given at the conference “Frontiers in Monetary Policy Research” at the St. Louis Federal Reserve, October 19 2006. Of course, I can’t stick to the topic and offer a survey instead. In particular, lots of salty comments on the “conundrum” in long bond prices (silly, in my view). The paper from the St. Louis Fed website.
The Dog that Did Not Bark: A Defense of Return Predictability
Review of Financial Studies 21(4) 2008 1533-1575. Taken alone, returns may not look that predictable. However, price-dividend ratios vary, so either returns or dividend growth must be forecastable (or both). Implications for dividends, and long-run forecasts give strong statistical evidence against the null that returns are not forecatsable. I address the Goyal-Welch finding that forecasts do badly out of sample, and the long literature criticizing long-run forecasts. The most important practical takeaway: even if you assume that all variation in market p/d ratios comes from time-varying expected returns, and none corresponds to dividend growth forecasts, you will typically find that market-timing strategies based on fitting the regression don’t work. Corrected Table 6. Three numbers were wrong in the published version. Thanks to Camilla Pederson for catching it.
Review of Financial Studies 21(4) 2008 1533-1575. Taken alone, returns may not look that predictable. However, price-dividend ratios vary, so either returns or dividend growth must be forecastable (or both). Implications for dividends, and long-run forecasts give strong statistical evidence against the null that returns are not forecatsable. I address the Goyal-Welch finding that forecasts do badly out of sample, and the long literature criticizing long-run forecasts. The most important practical takeaway: even if you assume that all variation in market p/d ratios comes from time-varying expected returns, and none corresponds to dividend growth forecasts, you will typically find that market-timing strategies based on fitting the regression don’t work. Corrected Table 6. Three numbers were wrong in the published version. Thanks to Camilla Pederson for catching it.
International Risk Sharing is Better Than You Think, Or Exchange Rates are Too Smooth
With Michael Brandt and Pedro Santa Clara. Published Journal of Monetary Economics 53 (4) May 2006 671-698. Original July 2001 (NBER WP 8404) The equity premium means that marginal rates of substitution are very volatile, with more than 50% standard deviation. Exchange rates are the ratio of marginal rates of substitution, and they only vary by about 12%. Therefore, marginal rates of substitution must be highly correlated across countries. Risk sharing is better than you think.
With Michael Brandt and Pedro Santa Clara. Published Journal of Monetary Economics 53 (4) May 2006 671-698. Original July 2001 (NBER WP 8404) The equity premium means that marginal rates of substitution are very volatile, with more than 50% standard deviation. Exchange rates are the ratio of marginal rates of substitution, and they only vary by about 12%. Therefore, marginal rates of substitution must be highly correlated across countries. Risk sharing is better than you think.
Financial Markets and the Real Economy
Volume 18 of the International Library of Critical Writings in Financial Economics, John H. Cochrane Ed., London: Edward Elgar. March 2006. Edited volume of collected articles with an introduction surveying the field.
Volume 18 of the International Library of Critical Writings in Financial Economics, John H. Cochrane Ed., London: Edward Elgar. March 2006. Edited volume of collected articles with an introduction surveying the field.
Time series for macroeconomics and Finance
Lecture notes for PhD time series course. This revision finally includes the figures!
Lecture notes for PhD time series course. This revision finally includes the figures!
Writing tips for PhD students
May 2005. Some tips on how to write academic articles. Do as I say, not as I do. Chinese Translation, 2013. (Original source of chinese translation. Thanks to Shihe Fu)
May 2005. Some tips on how to write academic articles. Do as I say, not as I do. Chinese Translation, 2013. (Original source of chinese translation. Thanks to Shihe Fu)
Money as Stock
Journal of Monetary Economics 52:3, (2005) 501-528. Revision of NBER Working Paper 7498 Feb. 2000. The fiscal theory of the price level made simple. The `government budget constraint' is not a constraint. I reopen the security market at the end of the day in a cash in advance model, and show that the price level is still determinate. I also resolve the criticism that the fiscal theory mistreats the "government budget constraint."
Journal of Monetary Economics 52:3, (2005) 501-528. Revision of NBER Working Paper 7498 Feb. 2000. The fiscal theory of the price level made simple. The `government budget constraint' is not a constraint. I reopen the security market at the end of the day in a cash in advance model, and show that the price level is still determinate. I also resolve the criticism that the fiscal theory mistreats the "government budget constraint."
Bond Risk Premia
With Monika Piazzesi. American Economic Review 95:1, 138-160 (2005). We forecast one year bond excess returns with a 44% R2! More importantly, a single factor, a single linear combination of yields or forward rates, forecasts one-year returns of all maturity bonds. Read here the Appendix with lots of extra analysis. (Updated Sept 2006 to fix typos in forward rate formulas.) The NBER working paper has lots of cool stuff, including links to macro and the covariance with level result, that got trimmed from the published paper. Data and programs. Look at the pretty plot of how our forecasts work out of sample since we wrote the paper (Until the 2008 financial crisis, in which the Fama-Bliss procedure breaks down.) Read the Response to Ken Singleton regarding his criticism of our results in a paper with Dai and Yang, and then published in his book Empirical Dynamic Asset Pricing (Princeton, 2006). Overheads, useful if you want to teach the paper A summary with color graphs, and treatment of the period since the 2008 financial crisis, in lecture note form. Start on p 567.
With Monika Piazzesi. American Economic Review 95:1, 138-160 (2005). We forecast one year bond excess returns with a 44% R2! More importantly, a single factor, a single linear combination of yields or forward rates, forecasts one-year returns of all maturity bonds. Read here the Appendix with lots of extra analysis. (Updated Sept 2006 to fix typos in forward rate formulas.) The NBER working paper has lots of cool stuff, including links to macro and the covariance with level result, that got trimmed from the published paper. Data and programs. Look at the pretty plot of how our forecasts work out of sample since we wrote the paper (Until the 2008 financial crisis, in which the Fama-Bliss procedure breaks down.) Read the Response to Ken Singleton regarding his criticism of our results in a paper with Dai and Yang, and then published in his book Empirical Dynamic Asset Pricing (Princeton, 2006). Overheads, useful if you want to teach the paper A summary with color graphs, and treatment of the period since the 2008 financial crisis, in lecture note form. Start on p 567.
Asset Pricing
Revised Edition. link gives you a sample chapter. Click here to go to the Princeton University press website where you can order the book. (It is sometimes cheaper at Amazon.com or Barnes and Noble.com. In Chicago, it’s available at the seminary COOP bookstore.)
Additional materials for Asset Pricing, lecture notes, new chapters, and the online class are now moved to their own page here, or via the Asset Pricing link at left.
Revised Edition. link gives you a sample chapter. Click here to go to the Princeton University press website where you can order the book. (It is sometimes cheaper at Amazon.com or Barnes and Noble.com. In Chicago, it’s available at the seminary COOP bookstore.)
Additional materials for Asset Pricing, lecture notes, new chapters, and the online class are now moved to their own page here, or via the Asset Pricing link at left.
Investments notes
Notes for MBA investments classes. Summary of background (statistics, regression, time series, matrices, maximization) and a concise treatment of some of the standard topics (bond notation and expectations hypothesis, bond pricing)
Notes for MBA investments classes. Summary of background (statistics, regression, time series, matrices, maximization) and a concise treatment of some of the standard topics (bond notation and expectations hypothesis, bond pricing)
Liquidity, Trading and Asset Prices
NBER reporter, Jan 2005. A review of these issues in asset pricing.
NBER reporter, Jan 2005. A review of these issues in asset pricing.
Time series for macroeconomics and Finance
Jan 2005 Lecture notes for PhD time series course. This revision finally includes the figures!
Jan 2005 Lecture notes for PhD time series course. This revision finally includes the figures!